Indirect Tax Structure In India: A Case For Price Or Market Distortions

Posted in Finance Articles, Total Reads: 2017
, Published on 26 April 2015

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The indirect taxes that are levied on consumer goods In Indian Union and States on their journey from the factory warehouse to the final consumer points include Central Excise Duty(ED), Central Sales Tax(CST), local Sales Tax(VAT), Entry Tax(ET). Component of all these taxes in the final Invoice value-whether included in the invoice value or shown separately- can be a significant sum. Hence any difference in tax rates across states and tax evasion in any sector can cause distortions in the market. This is particularly true in respect of high value but low volume goods.

For a better understanding a brief introduction of different types of indirect taxes, at present being charged in Odisha at the final consumption point is attempted below:

(a) CENTRAL EXCISE: This is a tax levied by the central government at the manufacturing point. Tax is calculated on the value of the goods at the stage these leave the factory warehouse and enter the market. This may be a quite significant sum. Manufacturers stand to stand gain if the value is understated.

(b) CENTRAL SALES TAX or CST: With the primary aim of regulating inter- state trade and preventing multiple taxation in course of a single movement of goods between two or more states CST Act’1956 was enacted by Govt. of India and has been in operation w.e.f. 1/10/1958. The Act continues to be in force.

(c) LOCAL SALES TAX OR VAT: VAT which stands for Value Added Tax is a state tax on goods levied and collected by the state, in which goods are consumed. This is an indirect tax collected by dealers registered with the Govt. under statutory obligation. This is a major source of revenue for the states. VAT has been introduced in Odisha w.e.f. 1.4.2005.

(d)ENTRY TAX : This is a local tax levied by the state of Odisha on the value of goods entering any local area of the state. It is immaterial whether the said goods are for personal consumption or for sale. Even used or second hand goods entering the state can attract ET.

Market distortion created by the present tax structure:

A. Distortions in case of electronic products and how the E-commerce firms are getting tax advantage:

A trend has emerged in the recent times where in customers are preferring to purchase increasing varieties of goods including low volume and high value goods in particular through e-portal firms such as Flipcart, Amazon, Snapdeal, Myntra.com etc. Items like Mobile phones, Tablets, Laptops are increasingly getting sold. The delivery is done through couriers the local authorized dealers selling this products are bypassed. The service back up is provided by the manufacturer through authorized service centers which are either directly managed by the company or through franchise owners. In such cases the customers find that the product is generally cheaper by a substantial margin which can be as high as 20 to 30% than what he would have to pay in the local market. The companies are able to save by avoiding the normal stockiest distributor-retailer-customer chain by selling the goods directly from the warehouse through e-portals and therefore they are obviously in a position to pass on a part of this margin to the customer as price benefit. While this appears to be the marketing trend for the future for a large variety of consumer goods the fact remains that the present tax structure is also contributing to this trend.

This can be appreciated through an example.

 Mobile phones attract VAT@ 5% inside the state of Odisha in addition the dealer procuring these goods from outside the state is liable to pay Entry Tax@ 1% on the purchase value of the goods.

 Assuming that the purchase value of a particular model is 10000/- the dealer has to pay CST@ 2% (against c-form) and his purchase cost will be RS.10200/-

 Also assuming that the same is also his selling price i.e. profit is included there in he will have to charge Entry Tax of rupees 102 plus Output VAT of Rs. 515/-.

 Thus the minimum customer price will be Rs. 10817/-.

 Assuming that the same product is directly procured by the customer through e-portals and the basic price remains same the customer will be charged CST@ 5% (presumed to be the appropriate rate in the state of origin)

 In this transactions the couriers being unregistered do not pay Entry Tax and hence the customers avoids paying it all together.

 Thus the customer will get the product at the final price of 10,500/- earning a price benefit of RS. 317/- which is purely due to tax distortions and are extraneous to the marketing policies relevant to the product.

This price difference due to present tax structure can be better understood from the following tables:

B. The variation in price in case of automobiles:

Following introduction of VAT which is now operational in all the states of the country automobiles including commercial vehicles, passenger cars and tow-wheelers are being taxed at the general rate which at present is 13.5%. in automobile sector. It is learnt that automobile manufacturers do not, normally, operate outside state deports for logistical reasons. As such automobiles sold in these states attract minimum tax burden of 15.5% of the base price, comprising CST rate of 2% and local VAT of 13.5%. in addition dealers of the states like Odisha have to pay Entry Tax @ 2% which is passed on to the customer. As against this the dealers located in the states where the vehicles are manufactured charge only local VAT plus Entry Tax where applicable. Thus the price difference between two states owing to different tax rates can work out to as much as 4% in case the manufacturing state does not levy Entry Tax. This can cause significant distortion in the market which is kept in check only because vehicles are bulk goods.

C. Market distortion due to the tax law:

The price difference due to tax distortions can be a significant factor in altering customer behaviour the above example has been sited on the assumptions that the particular product that is mobile phones attract same tax rates in the states of origin as well as destinations there can be cases where the tax rates are different which will increase the margin of tax distortion. In case the product is tax exempted in the state of origin it can disturb the market in the particular segment. It is also unfortunate that CST which was supposed to be phased out with the introduction of VAT and to become completely zero rated within 3 years is still being levied at 2% throughout India. This is due to political considerations but totally unacceptable for a reformed tax structure. Continuation of CST at the present rate of 2% plus non-uniformity in application of VAT rates across the states has prevented coming of a PAN Indian market. In addition some states including the state of Odisha have continued to levy entry tax on a large category of goods on the entry to the state. Some of the goods liable to entry tax in Odisha are exempted from similar tax in our neighbouring states like West Bengal, Jharkhand, Chatisgard etc. To cite a few examples motor vehicles attract entry tax@ 2% in Odisha where as these are exempted in Jharkhand. Food items like edible oil, cereals are exempted from VAT and entry tax in Chatisgard where as these attract

VAT@ 5% in the state of Odisha. Difference in tax rates both in respect of VAT and entry tax is responsible for wide scale smuggling. This may be inducing consumers to directly procure from outside the state wherever feasible. This cross border smuggling as well as direct interstate purchase by the consumers of the state of Odisha can be attributed to the tax distortions of the nature described in the preceding paragraphs. This cannot be treated as a healthy scenario for the market as a whole.

GST and how it would play a vital role in creating a pan India market:

Hopefully the GST which stands for Goods and Services tax is going to end tax distortions of the above nature. GST is yet to be introduced but deserves a mention. GST is expected to revolutionize tax administration of all indirect taxes collected by Centre as well as states from the manufacturing point to the ultimate consumption point. All central taxes like Excise and Service Tax and state level taxes like CST, VAT and ET are to be merged into one. This is going to be extremely simple and transparent process and going to reduce tax evasion to a great extent. The detailed modalities of GST including likely rates and manner of sharing between Centre and States have not yet been finalized. It is known that technology is going to play a key role in its administration particularly in the area involving distribution of GST collections between the Centre and other states, who are going to be joint stake holders. GST is likely to curb evasion of ED and Local Taxes by unscrupulous manufacturers and traders by tying them in a continuous tax chain from the manufacturing to the retailer point across various distribution points. This may also prove to be extremely beneficial to trade and industry.

This article has been authored by Dipan Kumar Nayak from KIIT University(KSOM)

Reference:

While doing my summer internship I got to know that some of the tablets by HCL is offered at a much lower price to the customer by e-commerce firms such as Flipcart, Snapdeal etc. than the price at which the retailers’ buy. So there is a price distortion in the market. To verify the primary data was collected by interviewing various distributors, retail shop owners, sales managers and officials of the commercial tax dept. The secondary data was being collected from the invoices of different products as well as with the help of internet and newspaper articles. The various tax laws administered by the Commercial Tax department of Odisha (CTD in short) such as Central sales tax act- ‘1956’, Odisha VAT act- ‘2005’, Odisha Entry tax act- ‘1999’ have also been studied and referred to.